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Why American companies are getting 'old and fat'

·Senior Columnist
Why American companies are getting 'old and fat'

We relish startups. Twitter (TWTR), Facebook (FB) and Tesla (TSLA) are stock-market darlings. Steve Jobs, Elon Musk and Mark Zuckerberg are far more admired than any CEO who rose through the ranks. Starting a company and taking it public is one of our favorite David-and-Goliath narratives.

We’re not as entrepreneurial as we think we are, however — or as we used to be. And a sharp decline in the startup economy could have a lot to do with stagnant living standards and other financial pressures many Americans feel.

New research by economists Robert Litan of the Brookings Institution and Ian Hathaway of Ennsyte Economics shows fewer new firms are being created and more of those created are failing. Older and larger firms, meanwhile, account for a growing portion of economic activity. And this is not a recent development that can be blamed on the recession, but a 30-year trend that has intensified in recent years. “The business sector of the United States appears to be getting ‘old and fat,’” the researchers conclude.

There’s nothing inherently wrong with big, established businesses. Much-admired Apple (AAPL), which has now been around for about 35 years, is one. IBM (IBM), General Electric (GE) and Warren Buffett’s Berkshire Hathaway (BRK-A) are regarded as model firms that have weathered many booms and busts. Older firms, however, tend to be conservative operations that stick with what works and have less incentive to innovate than newcomers fighting for survival. “An economy that is saturated with older firms is one that is likely to be less flexible, and potentially less productive and less innovative than an economy with a higher percentage of new and young firms,” Litan and Hathaway write.

New firms also tend to hire the most, since they grow the fastest. Many of those firms fail, of course, but on balance, startups that grow into mid-sized firms and occasionally into titans — think Google (GOOG), Microsoft (MSFT) and Amazon (AMZN) — generate the kind of robust economic growth that keeps people employed and pay rising. In that regard, it’s probably not surprising that “jobless recoveries” have become the norm and more adults have dropped out of the labor force during the same time startup activity has waned.

In 1978, about 15% of all U.S. firms were startups. By 2011, that had fallen to about 8%. The failure rate of new firms is more jagged, falling from 10% in 1978 to 8% in 2002, but since then creeping back up to more than 9%. Fewer startups, by definition, means older firms will account for a larger portion of all firms. The chart below shows a breakdown by age, with firms that have been around for 16 years or more gaining market share, as it were, and all others losing share:

Source: Brookings Institution
Source: Brookings Institution

Economists aren’t sure why there’s a shortage of startups. Entrepreneurship, in theory, is more popular than ever. The 2011 biography of Steve Jobs was a mega bestseller. The TV show “Shark Tank”, which features entrepreneurial hopefuls pitching ideas to business barons such as Mark Cuban and Barbara Corcoran, has been a surprise hit. Entrepreneurship, meanwhile, has become a routine part of the curriculum at business schools.

Other recent trends ought to make it easier, not harder, to start a business. The cost of computers and other office equipment has plunged, and cloud computing now offers anybody plenty of cheap (or even free) digital storage. Crowdfunding sites includingKickstarter have gone from oddball to mainstream, even blessed by the federal government. Still, the startup numbers contradict the cultural and economic appeal.

One explanation may be the growing thicket of rules and regulations small-business owners must navigate. Conservatives love to bash the federal government for strangling businesses, but local rules such as licensing requirements and zoning restrictions may be a bigger deterrent to business success than anything out of Washington. There’s also a lot of needless overlap between local, state and federal rules, and policymakers at all levels are usually much better at passing new regulations than repealing outdated ones.

“Large, mature firms have the resources and experience to handle all those regulations,” Litan said in an interview. “A lot of startups have no way to keep abreast of the all rules. Some just do their thing, and if they get caught later, they just pay the fines.”

The lack of credit probably didn’t hamper business creation in the 1990s or early 2000s, but it may be doing so now. Silicon Valley tech startups backed by high-flying venture capitalists get most of the attention, but most new businesses — more than 95% — are tiny operations that get no outside funding at all (or any media exposure). Think corner delis, eBay sellers and one-person “consultancies” formed after a layoff. These days, anybody seeking a bank loan or even a bit of help from friends and family to start something as risky as a new business is facing tough odds.

There are a few things policymakers could do to try to boost startup activity. Automatic “sunset” provisions on regulations — requiring them to expire on a certain date unless reauthorized — could ease the regulatory burden on businesses. Allowing more “immigrant entrepreneurs” into the country could help, too, especially since immigrants start businesses at a much higher rate than native-born Americans. Litan would like to see colleges require an essay from applicants explaining their entrepreneurial interests, since that might force teenagers to think more about starting a business — and lead more of them to actually do it, eventually.

Or Americans themselves may simply need to muster more moxie, which, after all, is what entrepreneurs excel at. Until they get old and fat.

Rick Newman’s latest book is Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.